How to Ladder Annuities for More Income Than CDs
The advantage of using an annuity over a CD is that a deferred annuity grows tax-deferred, and immediate annuity payouts are only partially taxed.
All a CD's income is taxed as earned.
Here's a way to take advantage of the annuity's tax break to give you more income throughout your retirement years.
Let's suppose you have $100,000 for earning income using a Certificate of Deposit (CD) or an annuity.
Let's compare how you can receive income from them if they both earn at a 5% annual rate.
A $100,000 5yr-CD pays you 5% for an annual taxable income of $5,000.
At a 25% income tax rate, you're left with $3,500.
Of course you're also left with your $100,000 too, to reinvest later.
If income rates increase, your net income will too - and vice versa.
Now because an immediate fixed term annuity pays out both a portion of its earnings and your invested principal, you get more back during the year for an annuity earning 5%.
So a Single Premium Immediate Annuity (SPIA) based on investing only $20,000 and a 5 year certain payout gives you $4,248 income.
After tax (25% income tax rate) that still leaves you $4,186 which beats out your CD net income of $3,500.
But, of course, all the money in this SPIA is gone after the 5 years of payouts because you received your principal as part of its payments.
But if you use the remaining $80,000 to invest in deferred annuities in the meantime you can come out ahead in the end.
*An approach of laddering annuities: I'll assume you're 70; and with your $100,000, you buy 5 annuities each for a single premium of $20,000.
The first will be a Single Premium Immediate Annuity (SPIA) for a 5 year payout term as mentioned above.
The four others will be Single Premium (of $20,000 each) Deferred Annuities (SPDA) geared to produce a payout after 5, 10, 15, and 20 years respectively.
I've assumed a hypothetical accumulation interest rate of just 4.
5% - safely under the CD's 5% rate.
And I've kept the rate constant over time as a neutral scenario.
Increasing (decreasing) rates would affect both the annuities and the CDs together Let's consider what sort of income you'll generate under this arrangement.
These are hypothetical examples and all fees have been ignored.
The SPIA 5 year certain payout nets you $4,186 which beats out your CD net income - but those other 4 Deferred Annuities of $20,000 premiums each are still growing.
The (neutral) projected values of the 5, 10, 15, and 20 year SPDAs would be $24,924; $31,059; $38,706 and $48,234 when they become due as you turn 75, 80, 85, and 90 respectively.
The projected income they'd produce - as an SPIA - would be $5,292; $6,600; $8,220 and $10,248 during their 5 year term payout.
So your income is growing over time.
Now, to not lose all your investment if you live too long, you can - at age 85 - convert that $38,706 into a life-time single premium annuity that will pay you $6,348 per year for as long as you live and leave the last deferred annuity to grow as a legacy for your beneficiary.
Or you can just convert the last deferred annuity to a lifetime immediate annuity for even more income.
Remember, an additional advantage of a lifetime annuity is its payouts increase with your age since your remaining life expectancy is decreasing.
So you can see that the payout characteristics and taxation of annuities can work to your advantage as compared to using a CD.